We are in a raging bull market. Bull markets differ in characteristics and duration but most have some common characteristics. Stock market legend John Templeton beautifully summarised the evolution of bull markets when he said: “Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria.”
Where are we now in this bull market?
Sure, this bull market was born on pessimism when the pandemic triggered enormous fear and unprecedented lockdowns pushed the global economy into a severe recession. The sharp and swift crash of March 2020 spread gloom and doom and even die-hard optimists turned fearful. The seeds of this bull market were sown in that pessimistic phase.
As the markets recovered from the crash of March and started moving up in April, May and June, there was scepticism all around. The ‘economy-market disconnect’ was too apparent to ignore. From November 2020 on, the market can be assumed to have entered the stage of optimism. High-frequency data indicated strong growth revival. Q2 and Q3 earnings growth surprised even the optimists.
How long can this stage of optimism last?
Comparisons are made to the massive bull market of 2003-07, which took the Sensex from around 2,900 in May 2003 to above 20,000 by the end of 2007. Like the present bull market, the 2003-07 bull run was also powered by massive FPI inflows, assisted by a declining dollar. But, the real fundamental support for that bull market came from the impressive GDP growth (above 8 percent during 2004-08) and the spectacular earnings growth (around 30 percent CAGR during 2004-08) of that period.
Are we on the cusp of a similar breakout on GDP and earnings growth? Only time can tell. No one has a crystal ball.
Growth, earnings recovery support the bull run
The bull case is, indeed, strong. The market consensus is that interest rates in the developed world will remain low through 2023, facilitating sustained FPI flows into emerging markets like India.
If the growth and earnings recovery sustain, valuations will not look as intimidating as they appear now. The Budget 2021 has provided the perfect backdrop to sustain and accelerate the ongoing recovery. Therefore, the bull case is strong.
But, there is no valuation support
But valuations are high. Even if we assume a sharp bounce back in corporate earnings, markets are overvalued. The most optimistic projection of 30 percent growth in corporate earnings in FY22 put the Nifty EPS at Rs 740. So, at 15,200 level Nifty is trading around 20 times forward earnings, which is higher than the long-term average of 15.
Inflation, rising yields a threat
The major threat to the bull market is a steady rise in bond yields in the developed world, particularly the US. This can negatively impact FPI inflows and the bull run in all markets. On February 16, the US 10-year bond yield rose to 1.29 percent, the highest since February 2020.
Markets also appear to be concerned about the potential rise in inflation. The massive monetary stimulus being implemented by the Federal Reserve didn’t trigger inflation. But, since the Biden administration is keen on a massive $ 1.9-trillion fiscal stimulus that along with the monetary stimulus might trigger inflation. This is the biggest threat to the ongoing bull market.
New strains of the virus like the recently reported South African and Brazilian strains, pose another threat. Even though it is claimed that the efficacy of the vaccines will be high for the new strains too, there are some concerns regarding that.
The real threat to the bull market may emerge from a presently unknown factor. “Unknown unknowns” impact the market more than “known unknowns”.
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